For any business to be successful, it has to improve on sales in order to meet its shareholders’ expectations. If you would like your business to be successful, you are expected to optimize on its value even when the demand is low. One of the ways to ensure that you maximize on your business’ value is through incorporating corporate valuation measures. Such a measure is the market to book ratio we will discuss below.
These measures help to evaluate the strength and market potential of your organization. This article will walk you through the steps that you should follow to find your company’s market to book ratio. You will also read about ways in which you can use it.
What Is the Market to Book Ratio?
The market to book financial ratio (M/B) is also referred to as the price to book ratio. Also, it is used to measure the market value of a company in relation to its book value- accounting value. The market value is simply defined as the price that the market presumes the company is worth.
On the other hand, the book value is the amount that is left if you liquidate all your company’s assets and pay back all its liabilities. Therefore, you can use the market to book ratio to compare your company’s net assets relative to the sales price of its (your company) stocks.
Who Needs Market to Book Ratio the Most
The market to book ratio is important for numerous people in the business and financial world. For instance, investors use M/B to gain better insight into the market especially regarding the stock values of a firm. Other reputable professionals that rely on the market to book ratio include real estate companies, financial companies, and investment trusts, among others.
Mostly, the market to book ratio is suitable for companies that have tangible assets. You can use this ratio in your company to identify the amount equity investors pay for every dollar in net assets.
How to Obtain the Market to Book Ratio
You can find the market to book ratio through two ways. The first entails dividing the market value of your company by its book value.
Market to book ratio = Market value ÷ Book value.
This ratio can is traceable through using per-share values. It entails dividing your business’ current share price by the book value per share, i.e.
Market to book ratio = Share price ÷ Book value per share.
You also need to keep in mind that the M/B ratio varies from industry to industry. Moreover, your company’s share value should be higher than the book value. The reason for this is that the share price often depends on:
- How well your company uses its assets;
- The forecast future value of the company;
- Other financial parameters.
On the other hand, the book value does not account for the above. The book value does not include an estimate of how your business utilizes its assets to generate more revenue. This is why the share price is always higher.
How to Interpret the Market to Book Ratio
- When you get a high M/B ratio, it works to assure the shareholders and other investors in your business that your management team will improve on the value of their specific assets.
- Additionally, a high M/B ratio could mean that the shareholders expect management to match up to the market value of your business’ assets, which should be higher than the book value.
- On the other hand, a low M/B ratio, usually of less than one, implies that your stock fetches quite a low value. Moreover, a low M/B ratio should raise your concerns because it could mean that something is amiss within your business.
- A low M/B ratio is not particularly desirable in your business. This is because it could also mean that your business is paying out its expenses using too much of the amount that would remain in case your business is to become officially bankrupt.
- However, the M/B ratio must be interpreted by an expert. A low M/B ratio could also mean that the industry generally has a low M/B. This is because some industries usually generate low ROE, and others are cyclical.
However, when interpreting the market to book ratio, you need to know that it does not necessarily indicate or clearly point out to you the ability of your business to generate more revenue for its investors. In cases where a company is facing various financial constraints, you should calculate the M/B ratio a little different.
How is this so? You can calculate the book value after excluding the intangible assets that lack a resale value. In such cases, the calculation of the M/B ratio goes through changes. This is because stock options have the legal right to:
- Fire the management team;
- Change those in control;
- Decide on the sale of a business especially when its performance is below the stockholders expectations.
To Sum It Up
The market to book ratio helps you determine whether your business’ asset value can compare to the market price of its (business) stock per se. As you already saw, the market to book ratio varies from one industry to another. This implies that if you intend to compare your ratio with the ratio of another company, you should select a company within your industry for a more accurate comparison.
If you own a business, you can follow the formula from this article to find your business’ market to book ratio. Generally, this ratio can be the ratio that you use to measure the market value of a business in relation to its (the business) accounting value. This ratio is quite useful. This is because it can help businesses determine if their asset value is comparable to the firm’s stock price in the current market.
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